Kerry's tax epiphany makes some cents

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John Kerry's corporate income tax reform, announced last week, was a
welcome recognition that incentives matter.

Until now, Kerry has been demagogically denouncing "Benedict Arnold CEOs"
who move corporate headquarters and jobs out of the United States.

But his tax reform proposal is grounded in the sober recognition that the
real problem isn't the patriotism of corporate officials but a U.S.
corporate income tax rate that is too high.

The nominal U.S. corporate income tax rate is 35 percent. According to a
Department of Treasury study, cited by Kerry, the effective tax rate of
American corporations is nearly 50 percent higher than the international
average, 31 percent compared to 21 percent.

Moreover, unlike most of our international competitors, the United States
also taxes the foreign-earned income of domestic corporations. American
companies get a credit for foreign income taxes paid, but still owe Uncle
Sam the difference between the lower foreign rate and the higher U.S. rate.

This is the reason some American companies are reincorporating elsewhere.

They will still pay the high U.S. rate on income earned in the United
States, but will no longer also pay that higher tax on foreign income.

This high tax rate on foreign earnings also places U.S. companies at a
disadvantage in international trade. To compensate, American tax law allows
companies that form foreign subsidiaries to defer the higher U.S. tax until
the money is actually repatriated to the U.S. parent.

As Kerry points out, this creates a tax incentive both to move jobs
associated with international trade out of the U.S. and to leave capital
earned in foreign markets at work there.

To ameliorate these effects, Kerry proposes to reduce the corporate income
tax rate modestly, to 33.25 percent.

He also proposes to allow U.S. companies a one-time opportunity to
repatriate foreign earnings at a 10 percent tax rate. At present, there is
nearly $640 billion in accumulated foreign earnings being deferred.
These are solid, useful proposals. But Kerry, unfortunately, wasn't willing
to follow his epiphany that tax incentives matter to its logical
conclusion, which is that the United States should stop trying to tax the
foreign earnings of domestic corporations.

Instead, Kerry continues the deferral scheme, but only for money earned in
the specific country in which facilities are located. In other words,
earnings from international trade by U.S. foreign subsidiaries would be
instantly subject to the still higher U.S. tax rate.

This would place U.S. foreign subsidiaries at an even greater competitive
disadvantage. And substantially increase the incentive for U.S. companies
with significant international earnings to reincorporate elsewhere.

Kerry says he would stop the "abuse" of companies reincorporating offshore,
but that's easier said than done. And if done, would simply make U.S
companies with substantial international income an even more inviting
takeover target for foreign companies.

Kerry also couldn't resist a little industrial policy. He would provide an
income tax credit to offset the payroll taxes for new-hires in
manufacturing, other sectors subject to outsourcing and small business.
Of course, it's economically counterproductive to use tax benefits to
offset comparative advantages other countries may have. That simply delays
needed economic adjustments.

If government is to ameliorate the dislocations of international
competition, President Bush's proposal for individual retraining accounts
makes far more economic sense.

By extending his payroll tax credit to small businesses, Kerry claims to be
taxing them at a lower rate than Bush. But this ignores his personal income
tax proposal.

Many small businesses have forms of organization, such as Subchapter S
corporations, in which the earnings pass through to the owners and are
taxed as personal income. They may be hit by Kerry's proposed higher rates
on incomes more than $200,000 a year.

The Bush campaign instantly denounced Kerry's corporate tax reform
proposals, saying they would make things worse. In some respects, that's
true. But the Bush administration, for its part, has largely neglected
corporate tax reform.

The most important feature of the Kerry plan is a recognition that a high
U.S. corporate income tax rate is a serious problem. After "Benedict Arnold
CEOs," that's both a relief and a serious contribution.

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